Germany and France push short-selling disclosure; AIMA issues warning

Proposed short selling rules, variations of which have been adopted in France and Germany, could push equity capital out of Europe and restrict liquidity.

The concerns are raised in a study by management consultant Oliver Wyman, commissioned by the Alternative Investment Management Association (AIMA), the industry body for hedge funds. Proposals made by the European Commission on 15 September 2010 are due to be adopted by the Economic and Financial Affairs Committee on 14 February. The rules will be voted on in a plenary session on 5 April, with political agreement scheduled by the Council of the European Union in May.

Under the proposals, market participants must notify regulators of net short-selling positions in selected stocks if a threshold of 0.2% or more is reached and publish their net short-selling positions if they reach a threshold of 0.5% or more.

Exactly half of the 34 funds interviewed as part of the AIMA study were very concerned about liquidity being reduced as a direct result of disclosure proposals, with another 36% expressing some concern.

The research also found that 69% of respondents were concerned that short squeezes would intensify if the measures were implemented, meaning that if some participants know of others' short positions, they will be more likely to acquire a stock knowing that covering of the short position will need to take place and thus further raise the stock price, which potentially facilitates a squeeze on liquidity.

In total, 75% of respondents said they expected equity capital to move out of Europe, 31% in the short term and 44% in the long term.

The study concluded that European policymakers should adopt a regulatory framework in line with financial jurisdictions that do not rely on public disclosure by individual managers. Private disclosure to regulators and public disclosure of, for example, short interest, has proven to be a “balanced” approach, says the study.

“The hedge fund industry supports increasing market transparency through the publication of aggregated short positions. We also support reporting of positions to national regulators. But as the findings of this independent study highlight, there are serious unintended consequences of disclosing individual managers' positions to the market – including a decrease in liquidity, lower returns for end investors including retail investors, and the likelihood that investments will move to other jurisdictions where returns are not constrained by inappropriate regulations,” said Andrew Baker, CEO, AIMA.

Meanwhile regulators in Germany, Bundesanstalt fÃ¼r Finanzdienstleistungsaufsicht and France, Autorité des Marchés Financier, instigated versions of this short position disclosure regime on 31 January and 1 February respectively. In Germany the thresholds will apply until 25 March 2012 to the stocks of ten financial firms: Aareal Bank, Allianz, Generali Deutschland, Commerzbank, Deutsche Bank, Deutsche Börse, Deutsche Postbank, Hannover RÃ¼ckversicherung, MLP, and MÃ¼nchener RÃ¼ckversicherungs-Gesellschaft. In France it will apply to stocks listed on the main Euronext and small- to mid-cap Alternext markets.

If passed by the European Parliament, the rules would be applied permanently by national regulators and overseen by the European Securities and Markets Authority (ESMA) a body that enforces regulatory harmonisation across Europe. In addition to the disclosure rules, the proposal would give national regulators powers to temporarily restrict or ban short selling in any financial instrument, subject to coordination by ESMA in exceptional situations. ESMA is also to be given the power to issue opinions to competent authorities when they intervene in exceptional situations and will have the option, when certain conditions are fulfilled, to adopt temporary measures itself, with direct effect, restricting or prohibiting short selling.

In addition, if the price of a financial instrument falls by a significant amount in a day, national regulators will have the power to restrict short selling in that instrument until the end of the next trading day. These measures will help regulators take the necessary action, in a coordinated way, to slow or halt price declines which can be amplified by short selling in distressed markets. They will also reduce compliance costs for market participants which currently arise from the divergence of national rules.